How To Start Investing in Rental Properties
Thinking of purchasing an investment property? There are many reasons to believe that real estate is a good investment. It has been the source of wealth for many of the most successful people on the planet. Experts agree that you should be educated before investing hundreds of thousands of money. Before you buy your first rental property, here are some things to keep in mind.
It's possible to earn a good income as a landlord. However, it's not an easy job. There are many headaches and problems that go along with selecting the right property, prepping it, and finding trustworthy tenants. Do you know how to use a toolbox properly? Are you able to repair the drywall and unclog the toilet? While you can hire someone to do the job, it will cut into your profits. Homeowners who own more than one home often save money by doing their own repairs.
Investor properties usually require a higher downpayment than owner-occupied properties. Additionally, they are subject to stricter approvals. Investment properties will require a higher down payment than the home you own. Due to the fact that rental properties don't have mortgage insurance, you will need a minimum 20% downpayment. A personal loan may allow you to make a down payment.
You don't want to be trapped with a property in an area that's declining, rather than stabilizing or growing. An area where there is growth in population and a plan to revitalize it is a good investment opportunity. A location that has low property taxes, good schools, and lots of amenities like restaurants, coffee shops, and shopping is a great place to rent a profitable property. Additionally, renters may be more likely to find a place with low crime, easy public transportation access, and a growing labor market.
Is it better for you to buy with cash than to finance your investment property? This depends on your investing goals. Cash can generate positive cash flow monthly by paying cash. Let's say you have a $100,000 rental property. A cash buyer can earn $9,500 per year with rental income, taxes, and depreciation. That's 9.5% return on a $100,000 investment. However, financing can provide a better return. Imagine an investor putting down 20% for a house and compounding the interest at 4% on the mortgage. After adding in operating expenses and extra interest, the annual earnings are approximately $5,580. Although cash flow is lower, a 27.9% annual yield on the $20,000 investment is more than the 9.5% earned by the cash buyer.
Although a rental property mortgage is the same as a primary mortgage, there are some important differences. Because borrowers in financial trouble tend to place their mortgage on their primary residence first, rental property loans are more likely to default. Due to the increased risk, lenders charge higher interest rates on rentals. For rental properties, the underwriting requirements are more stringent. The main criteria for mortgage lenders are credit score, down payment, and debt-to-income ratio. For rental property mortgages, the same factors apply. However, the lender may require a more strict credit score and DTI thresholds. Also, borrowers will be required to make a smaller down payment. Lenders may also look closely at the borrower’s employment history and income. They may want to see the previous landlord's experience.
Owners of rental properties have two options: either hire a property manager or manage it themselves. Property managers usually charge between 8% - 12% of rents collected, making it difficult to decide. It is often worth it to hire a property manager who has experience in the field. As they have industry experience, this means that you will be able to do less work and avoid headaches.
A property manager will usually:
- How to market your property
- Know the market in your area and price the rental accordingly
- Show potential tenants the property (so they don't have)
- Screen tenants (for example: conduct credit checks and verify references).
- Deposit the rent into your bank account and collect the rent.
- Take care of late rents, and guide the eviction process
- Handle tenant complaints
- Arrange maintenance or repair work
- Pay property-related bills like property taxes, utilities, and insurance
Ask these questions to determine if you can afford to hire a property manager.
- Can I find the time and energy to manage the property? A full-time job or other commitments will likely mean that you won't be able to manage the property yourself. This is especially true for multiple properties.
- How close is the rental property to my home? It takes more time to get to the rental than you would like and it makes it more difficult for you to deal with urgent and routine issues.
- Am I ready to deal directly with tenants? Even if you do an excellent job screening tenants, it is likely that you will have to deal at some point with unreasonable tenants, late rents, and evictions. Do you feel up to the task?
- Do I want to rent my property to long-term, or short-term tenants? You might find it easier to manage the property yourself if you are looking after long-term renters. However, if you are looking for a short-term renter (e.g. an Airbnb), then you will need to deal with many tenants. This can lead to a lot more complaints and maintenance issues.
- Is it necessary to have complete control? If you find it hard to manage the property, such as picking tenants or performing maintenance tasks yourself, then you might be better off hiring someone else to do so.